When Facebook (FB) went public a year ago, it was billed as "the next Google."
Excitement around the IPO was so intense that amateurs who knew little about the company and less about investing were elbowing each other out of the way to get stock.
And then the company finally went public... and the stock flopped.
A year later, Facebook's stock is down 40% from its IPO price, and few people seem excited about the company anymore.
So, what gives?
From a broad perspective, Facebook is going through the same maturation process that many rapidly growing tech companies have gone through. It is transitioning from hyper-growth to steadier growth, and the stock "multiple"--the price that investors are willing to pay for the shares relative to the company's earnings--is dropping accordingly.
Importantly, this is nothing new: Google (GOOG) went through the same process from 2007 to 2012. Amazon (AMZN) went through the same process from 1999 to 2005 or so. As the growth of these companies slowed, and their results no longer positively surprised investors, their stock multiples compressed. The same thing is now happening to Facebook.
Despite concerns about privacy and teens defecting to other services, Facebook is still a great company, with a great management team, and a big long-term opportunity. Facebook is still growing at a very healthy rate, especially relative to most big companies. And Facebook still has lots of "platform" opportunities that may lead to big revenue opportunities in the future.
If investors are willing to bet that, at some point, those platform opportunities will unlock a huge revenue engine that will cause Facebook's revenue and earnings to skyrocket, then the stock should be a good investment at this level.
But, otherwise, Facebook's "multiple compression" will likely continue for a while longer. And the stock will likely trade in the same range that it has been trading in since the IPO.
Because Facebook's stock is still expensive relative to some other big tech companies, namely Apple (AAPL) and Google.
Facebook is now trading at about 40X this year's expected earnings. That compares to:
- Google: 20x
- Apple: 11x
Yes, there are some hot growth companies that trade at even higher multiples than Facebook, such as LinkedIn and Amazon:
- LinkedIn: 115x
- Amazon: 200x
But the profit margins of LinkedIn (LNKD) and Amazon are low and rising, whereas Facebook's profit margin is high and falling. This means that earnings at LinkedIn and Amazon are likely to grow vastly faster than earnings at Facebook over the next few years. And LinkedIn's revenue is growing twice as fast as Facebook's, which means that the company deserves a much higher multiple.
(And Amazon's valuation, especially, is almost inconceivably high. As an Amazon shareholder, I thank those who are loading up on the stock at this price, but I have no idea what they're thinking.)
Now, there are times when valuation just doesn't matter. Momentum investors, for example, don't care about valuation. What momentum investors get stoked about is acceleration and upside surprises.
But are we going to get those again at Facebook?
It's possible. But unless Facebook stumbles upon a massive new revenue engine, it doesn't seem likely.
Some other facts to consider:
- Facebook's non-advertising revenue--payments, Gifts, etc.--is not growing at all. Specifically, payments revenue is declining, and the small revenue from Gifts, et al, are not yet meaningful enough to make this revenue line grow. This means that all of Facebook's growth has to come from ad revenue.
- Facebook's mobile revenue is already 30% of Facebook's total ad revenue--in part because the growth of Facebook's desktop ad revenue has flattened.
- Facebook's mobile ad opportunity may already be more penetrated than you think.
- Facebook's user growth is now coming in emerging-market countries in which there is little to no advertising revenue. The 1 billion users that Facebook already has have most of the money and purchasing power in the world. So the next 2-3 billion users that Facebook adds won't be worth as much in terms of ad revenue as the 1 billion that Facebook already has. This, too, will likely temper the company's revenue growth rate.
The bottom line is this:
Facebook is likely in the middle of a long-term transition process in which the stock's multiple gradually compresses from a super-high "momentum" multiple to a more reasonable "growth" multiple (say, 20x-25x). That process often takes years.
At $23, Facebook's multiple has compressed to about 30x next year's expected earnings. That is approaching reasonable levels, so the stock may find a bottom at some point. But barring a strong re-acceleration in Facebook's revenue growth, it seems unlikely that investors will suddenly go as loopy for the stock as they did before the company went public.
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